Increased expectations of a cut in the Fed funds rate next month may push the Federal Reserve Bank into a corner as far its ability to contain further market selling and the resulting contagion from such declines. How markets would react in the event of no September rate cut is a question related to market psychology and expectations. But the deteriorating fundamentals in housing and the latest figures on rising delinquencies is expected to weigh on the macroeconomic climate to the extent of ultimately pushing up the unemployment rate—an important prerequisite for a rate cut.
As the charts below show, the Fed has seldom began cutting interest rates without the unemployment rate registering a rise of at least 0.2% points. A recent exception, however, took place in November of 1998, when the Fed eased rates despite a drop in the jobless rate – an effort to inject liquidity to counter the market meltdown precipitated by Long Term Capital Management. That exception was corroborated by the fact that the 1998 easing was largely market driven and not economic driven.
Data watch and Jackson Hole watch
The July unemployment rate rose to 4.6% from 4.5%. But without rounding, the rate was at 4.647%, nearly attaining 4.7%, a level not reached since August 2006. Could 4.7% be reached at the August figure due on September 7, thereby, paving the way for a Fed easing on September 18? There may be sufficient macroeconomic evidence for such a move from the incoming figures on new home sales, existing home sales, second quarter preliminary GDP, personal spending, core PCE price index, manufacturing and services ISM and confidence figures from the University of Michigan and the Conference Board, all of which are due before the September Federal Open Market Committee (FOMC) meeting. More specifically, another reading below 2.0% in the core PCE price index due August 31 will be key in elevating expectations of a Fed cut. This would be especially the case if we see the fourth-consecutive monthly decline in existing home sales (due this Friday) and the third-straight monthly decline in new home sales (due Monday).
Another valuable indication on the Fed will be obtained from the annual retreat of the Fed and global central bankers in Jackson Hole, Wyoming. Fed governor Mishkin is already scheduled to speak about the transmission mechanism from monetary policy and housing market. Behind the scenes interviews of this event will be closely scrutinized.
USD/JPY eyes 115.80, but overall trend remains down
The 21% decline in Japan’s trade surplus in the year ending in June is having little impact on the currency, but the lack of U.S. economic data and increased expectations of a Fed cut next month may help reduce market volatility and place relief on the unwinding of carry trades for now. Nonetheless, we do see fresh reasons for renewed volatility both from revelations of struggling hedge funds, mortgage lenders and banks, as well as from the macro economic angle.
We do not expect any change in tomorrow’s interest rate decision from the Bank of Japan especially after the central bank skipped its regular bond sale operation overnight.
The daily chart on USD/JPY suggests a move towards 115.80 into the next two trading sessions, but the U.S. data on housing and durable goods may act as an obstacle. Support starts at 114.70, backed by 114.30.
EUR/USD capped at 1.3540
EUR/USD is seen extending gains towards 1.35, in the event of further stability in U.S. and global equity markets. Upside may extend towards 1.3540, which is the 38% retracement of the decline from the 1.3844 high. The 100-day MA stands at 1.3550. Chances of renewed pullback seen considerable, with 1.3450 acting as renewed market volatility may weigh on the pair anew, especially if wee see declines of more than 1.5% in U.S. equities. Support rises to 1.3450.
USD/CAD eyes 1.0550 amid reduced volatility
A positive showing in U.S. equities boosted by further reduction in Volatility is likely to drag USD/CAD towards the 1.0580s, despite falling oil prices. Yesterday’s CPI figures were in line with expectations, coming at 2.2% y/y and matching the June figure. Although retail sales fell by a greater than expected 0.9% in June, we expect USD/CAD to chart further retreat mainly due to improved stability in the market. But this could well change amid the first sign of nervousness, with the negative CAD data speeding up a short-term rebound towards 1.0630. Interim support stands at 1.0570, followed by 1.0550. Weekly candle chart suggests 1.05 remains within reach before week’s end.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
